Bill Gross

When the Federal Reserve meets this week, the Wall Street Journal reports the most challenging question won’t be where to push interest rates in the near term, but where they belong years into the future. The WSJ indicates policy makers have believed the benchmark interest rate — known as the federal-funds rate — should be about 4% in a balanced economy, but officials are now debating whether interest rates need to remain below that threshold long after the economy returns to normal (i.e. once inflation is stable at 2% and unemployment around 5.5%).

Pimco, the world’s largest bond manager with close to $2 trillion in assets under management, believes the federal funds rate will remain well below the “neutral” policy rate of 4% once the economy returns to full health. The firm is predicting a “new neutral” rate of 2% (nominal), given the highly leveraged economy. In the video above, Pimco founder and CIO Bill Gross says the difference is “critical” as the neutral policy rate “basically determines the prices of all assets.”

He tells us the biggest investment theme for the next five years will be, “how far does the Fed go in terms of their tightening and their journey back up, as opposed to down,” as the central bank moves to get out of the business of buying treasury bonds and mortgage-backed securities, and begins to raise rates from near zero.

While tightening may be the next phase of the monetary policy story, what does Gross think about the impact of the Fed’s easy money policies and how successful they have been over the last five years — with rates held near zero and the balance sheet expanded by trillions of dollars?

He says, “so far, so good.” Gross credits the Fed for over five years of “beautiful deleveraging,” as hedge fund titan Ray Dalio calls it. Gross also sees success in other factors, including real economic growth of 2%, institutions being shored up, the stock market being close to record highs and employment growing at 200,000 a month. He says it remains a legitimate question what the central bank can do when it stops buying bonds and starts raising rates, though, conceding that things could get ugly.

And while 2% growth is less than stellar considering a historical norm of 3.5% to 4%, the lower growth is inline with what Pimco dubbed the “new normal” for the economy back in 2009. More recently, economists such as Larry Summers have advanced the idea that the U.S. may be facing secular stagnation — a permanent slump, with the economy hindered by structural issues such as demographics and the automation of jobs.

In the video below, Gross says he agrees we are in a secular stagnation period and says it is difficult to get out of. He jokes that Summers “took our [new normal] idea and called it secular stagnation,” adding, “come on, Larry … give Pimco some credit!” Check out the bonus video for more.

“The age of credit expansion, which led to double-digit portfolio returns is over. The age of inflation is upon us, which typically provides a headwind, not a tailwind, to securities price – both stocks and bonds.” On Friday, Gross tweeted, “#Fed to buy mortgages ‘til the cows come home. Think 7% unemployment, 2.5% inflation targets.

Buy real assets…gold…a house!” In an interview with Bloomberg TV on September 5, Gross said, “Gold can’t be reproduced. It can certainly be taken out of the ground at an increasing rate, but there’s a limited amount of gold and there has been an unlimited amount of paper money over the past 20 years to 30 years and now…central banks are at their leisure in terms of basically printing money…You know, I am not a gold bug. I am just suggesting that gold is a real asset and will be advantaged if the Federal Reserve or the ECB central banks start to write checks in the trillions. So what my objective is, I am not sure. I just think it [gold] will be higher than it is today and certainly a better investment than a bond or stock, which will probably return only 3% to 4% over the next 5 to 10 years.”

Gross, the co-founder and co-chief investment officer of bond giant PIMCO, says it is time to write the obituary for stock investing as we know it.

Writing in his August investment letter, the manager of the world’s largest bond mutual fund said lower returns on stocks — and bonds, for that matter — means individuals will have to work longer to save for their retirements.

If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money

“If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money,” Gross wrote.

Gross, whose Pacific Investment Management Co has US$1.82-trillion in assets, took particular issue with the noted economist Jeremy Siegel, who popularized the notion that a portfolio of stocks can return on average 6.6% over the long haul.

“The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned,” he said.

In his April investment letter, Gross struck a similar tone on total return expectations. Gross then said investors should get used to smaller investment returns because of slower global growth and as the financial services industry continues to deleverage, or reduce its reliance on derivatives and borrowed money to generate higher returns.

This time around, Gross said at their currently low interest rates, investors should expect “mere survival” from their bond investments.“With long Treasuries currently yielding 2.55%, it is even more of a stretch to assume that long-term bonds – and the bond market – will replicate the performance of decades past,” he wrote.

In his August letter, Gross says the only “magic potion” monetary policymakers have to try and get higher returns for investors is through inflationary policies.

He said inflationary policies might work for bonds, but that they are bad for stocks. And over the long term, Gross said using inflation to solve retirement ills is not a real solution.

“Unfair though it may be, an investor should continue to expect an attempted inflationary solution in all almost all developed economies over the next few years and even decades,” Gross wrote. “The cult of equity may be dying, but the cult of inflation may have only just begun.”

“The problem with all of that of course is that inflation doesn’t create real wealth and it doesn’t fairly distribute its pain and benefits,” he continued.

Gross in June kept the proportion of U.S. government and Treasury debt in his US$263.4-billion Total Return Fund unchanged at 35% of assets, according to a report July 11 on the company’s website. Mortgages were at 52% for a second consecutive month. Pimco doesn’t comment directly on monthly changes in its portfolio holdings.

In developed nations, Gross has advised investors to favor debt of the U.K., as well as the U.S., as Germany faces risks related to the eventual costs required to end the region’s worsening sovereign and banking crisis.

The U.S. Treasury market is considered the cleanest “dirty shirts” for investors, Gross wrote in his previous commentary. “Don’t underweight Uncle Sam in a debt crisis. Money seeking a safe haven will find it in America’s deep and liquid, almost Aaa rated, bond and equity markets.”

Pimco’s Total Return Fund gained 7.3% during the past year, beating 73% of its peers, according to data compiled by Bloomberg.

“Offensively-minded risk takers in the markets have historically been the ones who have dominated the headlines and won the hearts of that beautiful gal (or handsome guy).

Aside from the rare examples of Steve Jobs and Bill Gates; however, the secret to getting rich since the early 1980s has been to borrowsomeone else’s money, throw some Hail Mary passes and spike the ball in the end zone as if you had some particular genius thatdeserved monetary rewards 210 times more than a Doctor…

He went on to say, “Low yields, instead of fostering capital gains for investors via the magic of present value discounting and lower credit spreads, begin to reduce household incomes, lower corporate profit margins and wreak havoc on historical business models connected tobanking, money market funds and the pension industry.

The offensively-oriented investment world that we have grown so used
to over the past three decades is being stonewalled by a zero-bound, goal-line stand.”

PIMCO’s investment strategy going forward:

Recognize zero-bound limits and systemic debt risk in global financial markets. Accept financial repression but avoid its impact when and where possible.

PIMCO head Bill Gross released his February Investment Outlook titled “Life – and Death Proposition”, discussing the potential fall out from a de-levering economy and the impact of near zero interest rates.

Highlights from the report include:

1) Gross believes “the transition from a
levering, asset-inflating secular economy to a post-bubble de-levering era may be as difficult for one to imagine as our departure
into the hereafter;”

2) He stated, “Zero-bound interest rates do not always and necessarily force investors to take more risk by purchasing stocks or real estate;”

3) As rates approach zero, “money can become less liquid and frozen by price”, limiting any potential appreciation on fixed income securities as rates cannot go lower, convincing investors to hold cash as opposed to
extending credit, a requirement for economic growth; and

4) In Gross’ conclusion, he says, “Where does credit go when it dies?
It goes back to where it came from. It delevers, it slows and inhibits economic growth and it turns economic theory upside down, ultimately challenging the wisdom of policymakers. We’ll all be making this thing up as we go along for what may seem like an eternity…

His conclusion “We are witnessing the death f abundance and the borning of austerity, for what may be a long, long time.”